How Do Renovation Loans Work? A Complete Guide

Renovating your home can be an exciting project, but it can also be quite expensive Many homeowners take out a renovation loan to help finance large home improvement projects and spread the costs over time. But how exactly do these loans work? In this comprehensive guide, we’ll explain the ins and outs of renovation loans so you can decide if one is right for your next home project

What is a Renovation Loan?

A renovation loan is financing that you can use specifically for home improvement projects. There are a few different types of loans that may fall under this category:

• Personal loans – An unsecured personal loan that you can use for any purpose, including renovations.

• Home equity loan – A loan that uses your home equity as collateral.

• HELOC (Home Equity Line of Credit) – A revolving line of credit that also uses your home equity as collateral.

• Cash-out refinance – When you refinance your mortgage for more than you owe and take the difference in cash to pay for renovations.

The most common type of renovation loan is a personal loan, since it doesn’t require you to have equity built up in your home already.

How Do Renovation Loans Work?

While the specifics vary slightly depending on the type, most renovation loans work something like this:

• You apply and are approved for the loan amount you need based on factors like your credit, income, and debt-to-income ratio.

• If it’s a secured loan, the lender will appraise your home to determine how much equity you have.

• Once approved, you’ll receive the funds in a lump sum (except with a HELOC, where you draw money as needed).

• You’ll make fixed monthly payments including interest over the loan repayment term, usually 2-7 years.

• The lender will deposit your payments each month until the loan is paid off.

So in short, renovation loans provide funds upfront that you slowly repay over time through predictable monthly payments.

What Can You Use a Renovation Loan For?

Renovation loans can be used to finance all sorts of home remodeling and repair projects, including:

• Kitchen or bathroom remodels
• Electrical and plumbing upgrades
• New flooring or carpeting
• Interior and exterior painting
• Roof replacements
• Room additions or extensions
• Deck or patio additions
• Swimming pool installation
• Landscaping upgrades
• Driveway or garage repairs

Basically, if it improves or upgrades your home in some way, you can likely use a renovation loan to pay for it. Cosmetic renovations like new fixtures or finishes are common, but you can also use the funds for necessary structural repairs.

What Are the Benefits of a Renovation Loan?

There are a few advantages to using a renovation loan rather than paying for upgrades in cash:

• Spreads costs over time – Rather than paying 100% of the costs upfront, you can make more affordable monthly payments.

• Conserves cash – For expensive projects, a loan preserves more of your cash savings for other needs.

• May have lower rates – Secured loans like HELOCs may offer lower rates than alternatives like credit cards.

• Fast funding – You can get approved and receive funds usually within a week.

• Increases home value – Renovations boost your home’s value, so a loan can be a worthwhile investment.

As long as you only borrow what you can reasonably afford to repay, a renovation loan can be a strategic financing option.

What Are the Drawbacks of Renovation Loans?

However, there are also some potential downsides to consider:

• Interest costs – You’ll pay more overall than if you paid in cash.

• Strict eligibility – Good credit and income are usually required for approval.

• Closing costs – Secured loans often have closing costs and fees.

• Declining home value – Your home value could go down over time, leaving you underwater on a secured loan.

• Missed equity gains – Money put toward interest is money not invested elsewhere long-term.

To decide if a renovation loan is your best move, carefully weigh the benefits against the costs and risks for your situation.

Where Can You Get a Renovation Loan?

You have several options for where to get a home improvement loan:

Banks and Credit Unions – Local banks and credit unions are a popular option, especially for secured loans against home equity. Approval may take a bit longer than online lenders though.

Online Lenders – Many online lenders like LendingTree and Lightstream offer renovation loans with quick, easy applications. These are often unsecured personal loans.

Home Equity Lenders – Specialty lenders like LoanDepot and New American Funding offer home equity loans and HELOCs.

Mortgage Lenders – Your current mortgage company may allow you to do a cash-out refinance for renovations.

Home Improvement Stores – Some chains like Home Depot offer credit cards and financing for their products and services.

Be sure to shop around and compare interest rates and fees to find your best deal. Checking your pre-qualification odds is a good way to explore options without impacting your credit score.

What Credit Score Do You Need for a Renovation Loan?

Each lender sets its own minimum credit score requirements, but most renovation loans require good to excellent credit—generally 670 or higher. The better your credit score, the more likely you are to be approved and the lower your interest rate is likely to be.

If your score needs work, you may need to explore bad credit loan options or alternative financing methods until you can improve your credit profile. Adding a cosigner with good credit could also help you qualify and secure better loan terms.

How Much Can You Borrow for Home Renovations?

For unsecured personal loans, loan amounts usually range from $1,000 up to $100,000. The amount you qualify for will depend on factors like your income, existing debt obligations, and credit history.

For secured home equity loans, you can typically borrow up to 85% of your available home equity. So if you have $100,000 in equity, you could potentially get approved for up to $85,000. However, some lenders are more conservative and stick to 80% or lower.

With a HELOC, you’ll be approved for a maximum line of credit that you can draw from as needed for renovations. A HELOC may give you access to more funds over time as you repay the balance and your equity grows.

How Much Do Renovation Loans Cost?

The cost of a renovation loan depends on the interest rate and fees. Personal loan rates start around 6%, while secured home equity financing may be under 5% for borrowers with good credit.

With secured loans, you’ll also pay closing costs and fees ranging from 2-5% of the loan amount. And if you use a credit card, you’ll pay very high ongoing interest if not paid off in full each month.

Always factor the total loan costs over the full repayment term into your budget, not just the monthly payments. And shop around—the total cost difference between lenders can add up to thousands of dollars.

Tips for Getting the Best Renovation Loan

Here are some tips to follow for getting the lowest rates and fees:

• Check your credit – Good credit means better loan terms. Give yourself time to correct any errors on your credit reports first.

• Compare multiple lenders – Whether banks, credit unions, or online lenders, shop around and compare quotes.

• Consider both secured and unsecured loans – See whether a personal loan or home equity loan offers better rates for your situation.

• Review all fees carefully – Closing costs, origination fees, and other charges add to your total costs.

• Ask about discounts – See if you qualify for any rate discounts by setting up autopay or having an existing account.

• Watch interest rates – Consider waiting if rates are forecasted to fall, or locking in if they are trending up.

Doing your research upfront can help you identify the most affordable financing for your renovations.

Alternatives to Renovation Loans

While loans are common, they aren’t your only option for funding home improvements. Here are a few other possibilities:

Savings – Save up cash reserves in a dedicated home renovation savings account.

0% Credit Cards – Use a 0% intro APR credit card and pay in full within the promo window.

Retirement Funds – Borrow from 401(k) or IRA funds and repay over 5 years to avoid taxes or penalties.

Government Programs – Look into potential grants, rebates or low-interest programs on offer in your area.

Home Warranties – File claims under home or appliance warranties when applicable to repairs.

DIY Labor – Save on the costs of contractors by taking on work yourself if you have the skills.

Depending on your financial situation and the type of renovations needed, a loan may or may not end up being your best course of action.

The Bottom Line

While renovation loans provide upfront funding convenience, they also add to your long-term costs through interest payments. Make sure to carefully weigh the pros and cons for your specific home improvement plans and budget before moving forward.

Be sure to shop around and negotiate the best possible loan terms. And always build some financial cushion into your home renovation budget in case of cost overruns. With the right preparation, a renovation loan can be an effective way to turn your home remodeling dreams into reality!